Oil sinks as distillate supply falls less than expected

SAN FRANCISCO (MarketWatch) -- Crude-oil futures closed with a nearly 2% loss Wednesday with surprise declines in U.S. crude and gasoline supplies unable to offset disappointment that distillate inventories fell much less than expected despite severe winter weather in much of the nation last week.

"Stocks of crude, gasoline and distillates were all down -- and more than normal for February, but distillates (heating oil and diesel) were only off 3 million barrels, which is less than market expectations," said James Williams, an economist at WTRG Economics.

"The bulls would be quick to point out that crude and distillates are below last year's numbers while ignoring that gasoline stocks are slightly higher," he said, in e-mailed comments.

On the other hand, "the bears would be equally quick to note that last year's stocks were exceptionally high as refiners positioned themselves for longer-than-normal maintenance period to reconfigure the refineries to handle the requirements for blending with ethanol," he said.

"Folks who like to trade on volatility should get a couple of good days out of this report," he said.

Crude for March delivery closed down $1.06 at $58 a barrel on the New York Mercantile Exchange after reaching a low of $57.50, which matched the intraday low from Feb. 8.

The contract nearly gave up the 2.2% it gained Tuesday, when traders bet that the recent cold snap would affect supplies and show some reduction of inventories of oil and its byproducts. Prices had also seen support from the International Energy Agency, which raised its forecast for global oil demand in 2007, citing higher demand from China.

Then on Wednesday, the Energy Department reported that distillate supplies, which include heating oil, fell for a third week, down 3 million barrels to total 133.3 million for the week ended Feb. 9.

They've fallen a total of 9.3 million barrels over the course of three weeks, according to the government figures, but many analysts had expected a drop in the latest week of 4 million or more.

The American Petroleum Institute reported a fall of 372,000 barrels to 135.1 million.

"Distillates inventories seem to be holding up despite the exceptionally cold weather over the past few weeks in the U.S. Northeast and Midwest," said Rakesh Shankar, an economist at Moody's Economy.com, in a weekly report issued after the supply data.

Meanwhile, crude supplies fell by 600,000 barrels to 323.9 million barrels. They've now declined 1 million barrels in the past two weeks, according to the data.

The American Petroleum Institute reported a drop of 3.4 million and set the total at 325.3 million.

Many analysts had expected to see an increase in crude inventories.

The change in motor gasoline supplies was surprising to some, falling 2 million barrels to 225.2 million in the latest week, according to the Energy Department. That was the government's first-reported decline in the fuel's supplies since early December.

They were down 603,000 barrels at 215.4 million last week, according to the API's figures, defying some market expectations for a climb of around 2 million.

Against this background, March heating-oil futures closed down 5.49 cents at $1.6383 a gallon while March reformulated gasoline futures added 0.71 cent to close at $1.6162 a gallon.

Refinery activity declines

The across-the-board declines in petroleum product supplies comes on the heels of a fall in refinery activity, with refinery utilization pegged at 86.6% of capacity last week, down from 87.3% a week earlier, the Energy Department reported.

"Maintenance work, and smaller accident-related outages in Texas and California, are weighing in refinery activity," said Shankar.

Total petroleum products supplied over the last four-week period were 5% above the same period last year, averaging almost 21.2 million barrels per day, the government report showed.

Of that, motor-gasoline demand averaged nearly 9.1 million barrels per day over the period, or 3.6% above the same time a year ago, it said. And distillate-fuel demand was up 7% to average 4.5 million barrels per day for the period.

"The most telling reason for bullish pressures on prices is the apparent rebound in demand for gasoline over the past four weeks," said Shankar. "After languishing through the fourth quarter and early this year, gasoline demand growth has clearly accelerated since mid-January."

The weekly demand data is very preliminary and often subject to "severe revisions," but "the apparent firming of demand coincides with some other reports of steady economic activity -- and with the latest IEA monthly report, which bolstered the expected global-oil demand by 230,000 [barrels per day] for 2007," he said.

"Look for the market to increasingly focus on this non-heating energy demand story in the next few weeks, as we transition away from the heating season," he said.

Weather eases

The weather is unlikely to support prices for much longer -- forecasts are promising warmer temperatures in the next week, said Edward Meir, analyst at Man Financial, in a morning note to clients.

The Organization of the Petroleum Exporting Countries won't be much help either. Recent comments from the Saudi oil minister have made it clear the cartel has little appetite for further output cuts, he said. "We are, therefore, somewhat weary about the upside potential here."

John Person, president of National Futures Advisory Service pointed out that the "recent storm in the North East [is] passing quicker than what was expected, so next week we might not see a serious decline in inventories."

"Therefore, crude oil is baking down -- but I believe it will be a buying opportunity near $56.50-$57.25 so watch for a quick reversal at that area," he said.

Natural-gas futures retreat

Rounding out the energy action Wednesday, natural-gas futures followed their energy peers lower as traders geared up for Thursday's release of weekly natural-gas supply data from the Energy Department, covering the week ended Feb. 9.

March natural-gas futures fell by 12.6 cents to close at $7.241 per million British thermal units after climbing more than 14 cents on Tuesday.

Analysts at Strategic Energy & Economic Research expect the report to show a decline of 264 billion cubic feet. That compares to a decline of 92 billion a year ago and the five-year average decline of 149 billion, it said.

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